Business value: Advisory practice case studies

The valuation of an advisory practice is similar to the valuation of any service-based company. Because of the lack of significant tangible assets, goodwill represents the greatest portion of value within such a company from a valuation point of view.

Goodwill is not based on revenue levels as much as it’s based on the resultant earnings and qualitative aspects of those earnings — consistency and sustainability — which is driven by the strength of underlying client relationships, coupled with a recurring and predictable fee structure.

Consider the following business-succession scenarios:

Jim gets maximum value

Jim has built his practice over the last 25 years. He has total assets of $100 million, representing 200 clients with average assets of $500,000 each. His clients have an average age of 61, and roughly half of them have an estate plan in place. Jim has made a diligent effort to get to know the children and beneficiaries of his clients so he can assist with the eventual transition of their wealth.

Jim primarily recommends fee-based products and derives a solid, recurring revenue stream of 120 basis points. He has a steady profit margin after paying his expenses, including the salaries of his associate advisors and sales assistants. Jim maintains a very systematic client service model, which has resulted in solid client retention over the last two decades. Jim has also instituted sales and operational systems, has trained his staff effectively to handle day-to-day operational issues and keeps diligent records. This “institutionalization” of his business will allow Jim to transition his practice in a more seamless manner. Jim has also managed to grow his practice consistently while maintaining a firm grip on his expenses, resulting in positive annual growth of cash flow on a year-to-year basis.

Jim’s combination of a manageable client base, “institutionalized” business model, high assets and revenue per client, consistent profitability, multi-generational business opportunities and proven client loyalty will help him get top dollar for his practice when he retires.

Stephanie has room for improvement

Stephanie has been in business for about 23 years. She also has $100 million in total assets, but this is spread over nearly 1,000 client households with average assets of just $100,000 each. Stephanie’s clients have an average age of 42. She generally does not have time to get involved with estate planning or meetings with her clients’ beneficiaries and other family members.

Stephanie’s client portfolios contain a wide variety of individual securities and mutual funds, which means her average turn ratio of 62 basis points can be volatile. She also has considerable client service pressure, since she serves a large number of clients with unique portfolios and has no system to manage this process. She pays the salary of her sales and administrative staffs, and although she has managed to grow her assets under management consistently, her cash flow position has increased only marginally on a year-to-year basis due to the large number of clients and the failure to implement efficient “institutionalized” processes.

Stephanie’s younger client base may offer the potential for organic business growth in the coming years. However, her unmanageable book, volatile revenue, and lack of control over service time and net profitability will force her to accept a much lower business valuation than Jim — even though their total assets are the same.

Previous: Practice values and the downturn, plus insight into valuation metrics and advice on how to improve and begin structuring operations for your own retirement. (Hint: Start now.)

Darren Miles is a chartered business valuator, president and founder of Fair Market Value Inc. darren@fmvi.ca

(04/01/09)